Sentiment towards commodity and natural resources stocks could be nearing its worst following the huge falls over recent years, according to Richard Scott, who has bought the likes of BlackRock World Mining for his Hawskmoor Vanbrugh and Distribution funds to play the long overdue recovery in the asset class. 
It’s hard to find a more hated asset class than commodities at the moment as while most developed market equities have delivered decent returns over the past five years or so, funds which have a bias towards natural resources have posted significant losses.
The reasons behind this significant fall from grace are largely due to the end of the so-called ‘commodity supercycle’, with slowing emerging market growth (most specifically China) leading to less demand and as a result falling prices.
On top of that, poor decision making on the part of company management teams – such as increasing supply as demand started to wane and unnecessary amounts of capex and M&A activity – have compounded the issue.
Performance of indices over 5yrs
Source: FE Analytics
All told, it means the FTSE All Share Mining index is down an eye-watering 48.49 per cent over five years compared to a 38.92 per cent gain from the wider UK equity market.
Commodities have also borne the brunt of the recent China-led sell-off, which has turned sentiment even more negative towards the sector. However, while Scott and his team already had some exposure to the asset class prior to latest correction, they have used the lower valuations on offer to buy more.
“We don’t want to get this out of proportion. Commodity exposure hasn’t been a large exposure for either of our funds but it has been one of the weakest performing areas for us over the last year,” Scott (pictured) said.
“Rather than just stand in the road like a rabbit in the headlines, we’ve thought long and hard about what we should do with our commodity exposure and where that part of the portfolios is best invested.”
Many would think that buying now is a dangerous decision. China’s economic growth continues to slow (in fact many warn it is heading for a ‘hard landing’) and given it is one of the largest consumers of the likes of iron ore, many warn that further losses are on the horizon.
However, Scott met with the natural resources team at BlackRock recently and he said the discussion raised a number of interesting points.
He says they asked the question whether investors can afford to be underweight commodities at the moment given some of the developments within the sector.
These include the evidence that mining companies have responded to the negative market, they are cutting capex, reducing costs, they are now focusing on returns and dividends while, at the same time, the supply-demand dynamic is starting to rebalance.
“Well the obvious answer is, yes you can well afford to be underweight natural resources because it’s been such a lousy area,” Scott said.
“However, it does strike us that BlackRock are right to point out that a number of things are starting to fall into place which in time will set the basis for a much better time for a number of the natural resources stocks.”
As a result, he and his team have changed the exposure within their portfolios to position for a sharp recovery in the commodities space over the coming years.
“It did lead us to change our exposure and we decided to sell the very diversified BlackRock Natural Resources Growth & Income fund and use some of the money to add to a far more focused portfolio, which is the BlackRock World Mining Investment Trust.”
“For example, we have brought in a 1 per cent holding in Vanbrugh over the late-summer months and within our Distribution fund, which is higher risk and has a greater need for income, we have brought in a 2 per cent position.”
The £381m BlackRock World Mining Investment Trust is headed up by Olivia Markham and Evy Hambro, who also runs the five crown-rated BlackRock Gold & General fund.
Hambro has managed the portfolio since May 2009, over which time it has lost 31.93 per cent and narrowly underperformed against its Euromoney Global Mining benchmark.
Performance of trust versus index under Hambro
Source: FE Analytics
However, as the graph above shows, the trust was well ahead of the index up until last year when a number of substantial stock-specific issues hurt the overall portfolio.
It is a concentrated and punchy portfolio, with the trust’s top 10 holdings accounting for 60 per cent of the total assets. The managers also hold some 25 per cent across UK-listed mining giants Rio Tinto and BHP Billiton.
Possibly as a result of that position, the trust is throwing off a high dividend yield of 9.8 per cent thanks to the recent falls.
“We don’t expect BlackRock World Mining to maintain its dividend at a yield of almost 10 per cent although some of the observers in the market think that’s possible,” Scott said.
However, Scott points out that while Glencore (which makes up a very small part of the portfolio) has suspended its dividend, both Rio Tinto and BHP Billiton have increased theirs. He says this highlights the changes in the sector, as companies are focusing on delivering shareholder value.
The trust currently trades on a 10 per cent discount, is geared at 18 per cent and has ongoing charges of 1.4 per cent.
Another area which has really struggled within the natural resources space is energy stocks, as the huge falls in the oil price last year thanks to oversupply led to huge share price losses.
According to FE Analytics, the oil price is down some 55 per cent over 12 months while the FTSE All Share Oil & Gas index has lost 28 per cent.
Performance of indices over 1yr
Source: FE Analytics
A number of experts think that oil companies are due a rebound though, such as Whitechurch’s Ben Willis and Apollo’s Ryan Hughes, and Scott sits in a similar camp. As a result, he has also been buying shares in the Riverstone Energy Investment Trust.
“It is run by one of the very best private equity outfits in the US, which runs £30bn of assets and has achieved compound annual returns for its investors of 20 per cent over the last 15 years. They have a fantastic record by investing in North American energy projects and they have been able to start building their portfolio though this difficult time for the energy sector.”
“They’ve still got 50 per cent in cash so they are taking advantage of difficult times to build a portfolio which is well positioned for the future.”
“Also, because it’s energy related the share price of Riverstone has sold-off very sharply whereas its net asset value has been remarkably stable and far better than most other energy-related investments. It is something we are really quite excited about for the future.”
Performance of trust versus index since launch
Source: FE Analytics
Since launch Riverstone Energy, which charges 1.03 per cent, has lost just 0.4 per cent while the FTSE All Share Oil & Gas index is down 21 per cent. As Scott points out, it is also trading on a relatively wide discount to NAV of 11.1 per cent.
